Wednesday, 12 January 2011

Cuts and Banks

They are, rather predictably, the issues on everyone who has a view on
'stuff's mind right now; the cuts, and the banks. In both cases, the
questions appear to boil down to 'are they going the right way?' and
'do we even need them?' If you're not too big on the whole reading
thing, I'll summarise now by answering simply 'yes' to both questions.

But, because national finances and economics are a fairly daunting
topic for even the most bored but aspiring Eton student, I shall begin
by sketching out a brief outline of the two problems we have - and it
*is* two issues. Don't let sneaky ruffians tell you they're the same

The first is the recession. Most recessions in the last century
occurred as a result of increased inflation. This is when a currency
effectively devalues. The 'inflation' here refers not to the value of
the currency, but to the supply - that is to say, that the government
has either printed, or the central bank has lent out to other banks, a
bit too much money. The more money there is sloshing around like this,
the less it ends up being worth, as there is no wealth to back it up.
If the Qatari government buys £10bn worth of fighter jets from a
British company, that's £10bn coming into the country in exchange for
goods, which bolsters the net worth of the UK by that much. If that
same British fighter jet manufacturer, instead, went to a bank for a
£10bn loan - and received it - they would still have as much money,
but because it's just a loan and not actually in exchange for any
product, all it's done is increase the number of pounds in the
country, which in turn devalues them all slightly.

Do this over and over and eventually no one wants to lend you any
money, because the currency you're using to pay it off with is
becoming worth less and less. This leads to recessions, in which
usually the value of things falls back down to what they actually are,
thus house prices falling (homes are particularly susceptible to this,
due to the fact that basically every home bought is done so with a
mortgage, ie a loan, as opposed to, for example, a packet of Rolos.)
Therefore, in these instances, the recession isn't so much a problem
as it is the cure. The problem was an I flared currency. The cure IS
the recession. What governments can do to help in these situations are
make the cost of hiring employees lower, by decreasing company-side
national insurance etc. This is a cure for the symptoms, but as I just
mentioned, the recession itself is a cure and doesn't need to be

This recession, however, was different. Our currenc didn't explode in
inflation as per the norm on the eve of a recession. That's because it
wasn't an inflationary recession, it was a debt based one. Over the
last 15 years or so, many governments around the world pumped a great
deal of money into their economies in the form of low interest rates.
These mean it's a lot cheaper for high street banks to offer loans to
people and businesses, which in turn creates growth. So far, so good.
The problems come when these loans trickle down to a few people who
can not reliably pay back their loans. In the US, the Clinton
administration put through a bit of vote-winning legislation that
effectively forced banks to lend to poorer families to help get them
on the property ladder. These people are grateful, which wins the Dems
votes, and figures of first time buyers going up is good for polls
too. The problem is that, well, banks make their money from loans. The
interest they charge is their income. So, given this, you have to ask
why the banks weren't voluntarily lending these people money in the
first place, and why it required government legislation to force them

The answer is that they were too risky. These groups failed the banks
tests of credit worthiness, which meant the risk of them defaulting on
the loan - not paying it back - was greater than the possible benefits
warranted. When the government effectively forced them too, they
created a demographic that have its name to the now infamous
'sub-prime mortgage collapse' - also known as 'trailer trash that
can't afford their mortgages stopped paying their mortgages and lost
their houses' which subsequently caused the whole house of cards to
fall down, so great were the banks liability in this group.

The US wasn't the only place that this occurred. Greece and Ireland
and Spains construction booms were financed using money that didn't
really exist, and when no one bought them - or, rather, the native
equivalents of the sub-prime mortgage Market did - again, the whole
thing collapsed. These all set off Domino reactions in the world of
finance, with people being less willing to lend to others, making the
whole system seize up. Debt is, after all, vital in any growing

So that's one problem. That's why businesses went bankrupt and why
lots of people in the private sector lost their jobs. This is,
however, different to the cuts.

The cuts are a result of a generation of spending being higher an tax
receipts. Since the recession, our deficit - the difference between
how much money the government gets in taxation and how much it
actually spends - has increased at largely a similar rate to how it
was increasing before the recession. It got a bump from the additional
people seeking welfare and the less people in work, but essentially it
was following an almost exponential progression. Bailing out the banks
were scarcely even considered here (for the simple reason that the
majority of the £850bn figure that gets banded around is actually
liability, and not how much we have actually spent, and the fact thay
the shares we have in Lloyds etc are still ours, and when those
companies become ready for sale, it's likely we will make a profit on
them - we didn't trade the money away for nothing, we got assets for

In short, our spending was vastly largely than our tax revenue for 8
of the 10 pre-recession budgets, getting larger every time. Thats why
we need to cut now. This would have caught up with us sooner or later.
The recession being debt-based was the catalyst that has forced us to
deal with this now, but blaming the recession for the cuts is like
blaming a surgeon for cutting your skin whilst he was operating on
your alcohol-soaked liver to stop you dying. The cuts need to occur
because, even without the recession, we were spending more than we
had, to the point that now, our annual interest payments - not
reductions in the deficit, or even reductions in the debt - are over
£80bn. That's more than our entire education budget. Every single
year. And yet people seem happy to call those endorsing cuts the
selfish ones.

The two issues are, whilst not isolated, also not the same thing. If
we hadn't been spending above our revenue for a decade, we wouldn't
need to be cutting now, recession or no. This may seem obvious, but
it's surprising how many people seem to think it's not. It was the
nasty bankers and their bonuses that enabled the government to borrow
so much for so long in the first place - and now they're the first
being accused of greed, rather than the UK tax payer.

I'll end it here because my trains nearly at my stop, but hopefully
this gives a fairly good indicator of my views on the cuts and banking
issue. Next post? University Fees!


1 comment:

  1. Hi Dan,

    Have you ever read any Austrian school economics?

    They also point to the cause of recessions being an increase in the money supply - you might be interested to hear how they explain it - I had a go over at my blog :)

    Interest rates are actual prices that need to reflect reality - and once they are artificially lowered by central banks investments take place that would not previously have been possible. This sets off a boom, but as there are no new real resources to fund them, the recession to correct this is inevitable.